Commenting on the unprecedented downgrade of Israel’s credit rating by international rating agency Moody’s, Bank Leumi chief economist Dr. Gil Bufman writes that the decision was flagged by a document published by Moody’s last November, and so is not really a surprise, but that further downgrades could be in the offing.
"Moody’s downgraded Israel’s sovereign rating for the first time ever, putting into effect the earlier document dated November 20, 2023, in which it detailed the grounds for such a downgrade, and for further downgrades as well, so there’s no surprise here. The rating was cut by one grade to A2, which puts Israel on a par with Poland and Chile.
"Looking ahead, Moody’s changed the rating outlook to "Negative", which opens the way to further downgrades if required," Bufman writes. On the current document, he says that it stresses the weaknesses arising from the political and security situation, the weakness of the executive and legislative organs, and the negative fiscal implications. Israel’s debt burden will be materially greater than was expected before the war.
"The new rating also takes into account Israel’s longstanding strengths, among them the growth characteristics of the Israeli economy, the central bank’s ability to stabilize the financial markets rapidly, and a strong banking sector and the government’s good access to the market for financing purposes. The negative outlook reflects Moody’s perception of the significance of the risk of escalation in the confrontation with Hezbollah in the north of Israel, which has the potential for a substantial negative impact on the economy. In addition, the consequences of the war in the Gaza Strip will be evident for a prolonged period, chiefly in the state budget.
"The report references the scenario in which the Ministry of Finance estimates that GDP could shrink by up to 1.5% in 2024, versus positive growth of 1.6% in its main forecast. Both these forecasts, particularly the pessimistic scenario, are higher (i.e., less bad) than our estimates. Bank Leumi’s forecast is of a worse hit in the various kinds of negative scenarios, and there’s a wide range of such scenarios. In the scenario of war in the north, the negative economic effects will spread to more sectors, and will affect more resilient sectors, for a longer time, and more deeply. Government finances will be under greater pressure in such a scenario, because of very high defense expenditures."
On the performance of the economy so far, Bufman writes, "The Israeli economy is performing reasonably well, and the indicators show an uptick in activity in the past three months. The labor force is getting back to where it was before the war, and reserve soldiers are being released. Construction to a large extent relies on Palestinian workers, and this sector is working at much lower levels than normal."
IBI Investment House chief economist Rafi Gozlan writes: "The rating downgrade was expected, but the negative outlook accompanying it was something of an unpleasant surprise. As usual, the decision by Moody’s represents confirmation by the rating agency of existing market pricing. Israel’s macro situation is known and is expressed daily in pricing on the markets, which for some time has reflected a rating downgrade.
"This worsening is also manifest in more expensive debt raising by the government of Israel overseas since the war broke out. Current pricing puts Israel nearer to the BBB group than to the A group in which it is rated by Moody’s and Fitch, and certainly in relation to the higher AA- rating by S&P.
"It’s reasonable to expect that the other rating agencies will follow in the footsteps of Moody’s in their forthcoming rating decisions, but not necessarily in their rating outlooks.
"It’s understood that if the war spreads to the northern border, this is a negative scenario for economic activity and for the fiscal situation that will entail a negative response from the rating agencies. Nevertheless, the government can minimize the future damage and prevent further rating cuts if it takes on board the criticism and acts to create a diplomatic horizon, at the same time as improving the fiscal situation with a revision to the 2024 budget that includes the closure of unnecessary government ministries, cancellation of the coalition party allocations, and diversion of resources to areas that support growth."
In response to the announcement by Moody’s, the Israel Business Forum, which comprises 200 of the heads of the largest companies in Israel, stated: "The rating downgrade and the setting of a negative outlook are dangerous developments the like of which we have not seen in 36 years, even during wars and previous challenges that we have coped with."
On the state budget, the Forum says, "This is the main tool by means of which the government influences the economy. The announcement by Moody’s is further proof that the 2024 budget proposal is not balanced and is insufficiently focused on measures to support growth and rehabilitation and recovery of the economy the day after.
"We believe that it is still not too late to submit a responsible budget with a lower deficit than was set and with an order of priorities biased towards growth led by the private sector, while encouraging innovation, creativity, and growth in productivity.
"We very much believe in the Israeli economy and its potential. The budget proposal for 2024 has not yet been debated and has not been finally approved by the Knesset. It is still not too late to introduce substantial changes that will express a vision of a different order of priorities."
Published by Globes, Israel business news - en.globes.co.il - on February 10, 2024.
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